Good Debts vs Bad Debts

Good Debts vs Bad Debts

Welcome to our new article on Back to Basics of personal finance. So far we have discussed The Rule of 72, The Magic of Compound Interest and Active Income vs Passive Income. My goal is to educate people on these basic principles and get used to it as if you are breathing them like oxygen. Personal finance is indeed a lifestyle – it’s not something you need to be ashamed of doing, nor do you have to hide in the dark that you’re doing it. Be proud! The fruits of your sacrifices will amaze you in the end.

If you look at the 10-point tenet list of our Facebook group, the first you see is actually to get out of debt. What debts are we talking about it? We are referring to bad debts. And even with good debts, you need to pay them off eventually.

Now, let’s talk about the difference between good debts and bad debts. So why have debts in the first place anyway?

Good Debts vs Bad Debts

Ang utang ay utang! Yes, while having this title doesn’t mean you go ahead and never pay or go ahead and never ever get a loan, knowing the difference between good debts and bad debts will make you more responsible.

So what’s the difference?

Good debts are those which you use to produce more money. So why take a loan then earn, how’s that possible? Well, supposed you are one of those qualified to take a cash loans on your credit card with a lower interest rate compared to a regular loan, and you made use of this amount to build an apartment or expand your business. Then, if the difference between the two interest rates (percent your earn minus percent you loan) is positive, meaning you earn more and not just offsetting each other, then you might be better off taking the loan and leverage. The key word is leverage. This is applicable if you believe that an extra cash or capital can be made into good use. If you have excess cash, why get a loan in the first place.

Bad debts are those which take money off your pockets. Debts which do not help at all but burden you and bring you sleepless nights. Credit cards collectors which call you everyday, at home or at the office and insist that you pay. You should, because you owe money. It’s not your money anyway. There are depositors out there who trust the bank to do good business with people who pay. Why be those people who do not pay.

Bad debts can arise from emergencies, such as having to support a relative in a hospital and pay dues. It can also arise from wrong decisions such as splurging on wants during sale season. The fact that you spend so much on shopping and get hit with debts, this means that there is lacking in your personal finance knowledge, that is having the budget for those kind of expenses, knowing the difference between needs and wants, and even securing yourself with emergency fund.

Good debts on the other hand can be a result of the need to expand a business. While you may have the cash to support the expansion, you may want to make use of other people’s money since you believe you can actually earn from their money.

What is a credit score?

Your credit score will suffer if you have a bad delinquency profile. We may not have one now, but as the country progresses, bank products become more regulated, a credit score will be something to look forward to. Banks and even telecommunication companies can utilize this information to assess whether to give you credit or not. Remember that how you handle your money reflects how you handle your character. Every loan is tantamount to a promise that you will pay. If you break that promise, what does it tell you about your character?

Leverage

Debt isn’t a bad idea after all. If you can make money out of using other people’s money and pay responsibly, then we have good business here.

In summary, your choice of getting a loan will depend on your purpose. If you believe that you can outwit the bank with generating higher rate of return than the rate at which you took the loan, then you are making most out of somebody else’s money. Most people would tend to agree – if you are holding cash, why take a loan anyway?